Application: International Trade

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1 Application: International TradeWhat determines whether a country imports or exports a good?

2 Application: International TradeWho gains and who loses from free trade among countries?

3 Application: International TradeWhat are the arguments that people use to advocate trade restrictions?

4 THE DETERMINANTS OF TRADEEquilibrium Without TradeAssume:A country is isolated from rest of the world and produces steel.The market for steel consists of the buyers and sellers in the country.No one in the country is allowed to import or export steel.

5 Figure 1 The Equilibrium without International TradePriceof SteelDomesticdemandConsumersurplusDomesticsupplyEquilibriumpricequantityProducersurplusQuantityof Steel

6 The Equilibrium Without TradeResults:Domestic price adjusts to balance demand and supply.The sum of consumer and producer surplus measures the total benefits that buyers and sellers receive.

7 The World Price and Comparative AdvantageIf the country decides to engage in international trade, will it be an importer or exporter of steel?

8 The World Price and Comparative AdvantageThe effects of free trade can be shown by comparing the domestic price of a good without trade and the world price of the good. The world price refers to the price that prevails in the world market for that good.

9 The World Price and Comparative AdvantageIf a country has a comparative advantage, thenthe domestic price will be below the world price, andthe country will be an exporter of the good.If the country does not have a comparative advantage, thenthe domestic price will be higher than the world price, andthe country will be an importer of the good.

14 THE WINNERS AND LOSERS FROM TRADEThe analysis of an exporting country yields two conclusions:Domestic producers of the good are better off, and domestic consumers of the good are worse off.Trade raises the economic well-being of the nation as a whole.

15 The Gains and Losses of an Importing CountryInternational Trade in an Importing CountryIf the world price of steel is lower than the domestic price,the country will be an importer of steel when trade is permitted.domestic consumers will want to buy steel at the lower world price.domestic producers of steel will have to lower their output because the domestic price moves to the world price.

20 The Gains and Losses of an Importing CountryHow Free Trade Affects Welfare in an Importing CountryThe analysis of an importing country yields two conclusions:Domestic producers of the good are worse off, and domestic consumers of the good are better off.Trade raises the economic well-being of the nation as a whole because the gains of consumers exceed the losses of producers.

21 THE WINNERS AND LOSERS FROM TRADEThe gains of the winners exceed the losses of the losers.The net change in total surplus is positive.

22 The Effects of a TariffA tariff is a tax on goods produced abroad and sold domestically.Tariffs raise the price of imported goods above the world price by the amount of the tariff.

30 The Effects of a TariffA tariff reduces the quantity of imports and moves the domestic market closer to its equilibrium without trade.With a tariff, total surplus in the market decreases by an amount referred to as a deadweight loss.

31 FYI: Import Quotas: Another Way to Restrict TradeThe Effects of an Import QuotaAn import quota is a limit on the quantity of a good that can be produced abroad and sold domestically.Because the quota raises the domestic price above the world price, domestic buyers of the good are worse off, and domestic sellers of the good are better off.License holders are better off because they make a profit from buying at the world price and selling at the higher domestic price.

32 The Effects of an Import QuotaThe quantity of imports is exactly the same as the horizontal shift in the supply curve.Firms with licenses to import, will supply more.Priceof SteelDomesticdemandThe Supply curve shifts horizontally by the amount of the licensed imports.DomesticsupplyEquilibriumwithout tradeDomesticsupply+Import supplyQuotaIsolandianprice withquotaEquilibriumwith quotaQSQDWorldpricePricewithoutquota=QSQDImportswith quotaQuantityImportswithout quotaof Steel

35 FYI: Import Quotas: Another Way to Restrict TradeWith a quota, total surplus in the market decreases by an amount referred to as a deadweight loss.The quota can potentially cause an even larger deadweight loss, if a mechanism such as lobbying is employed to allocate the import licenses.

36 The Lessons for Trade PolicyIf government sells import licenses for full value, revenue equals that of an equivalent tariff and the results of tariffs and quotas are identical.

40 CASE STUDY: Trade Agreements and the World Trade OrganizationUnilateral: when a country removes its trade restrictions on its own.Multilateral: a country reduces its trade restrictions while other countries do the same.

41 CASE STUDY: Trade Agreements and the World Trade OrganizationNAFTAThe North American Free Trade Agreement (NAFTA) is an example of a multilateral trade agreement.In 1993, NAFTA lowered the trade barriers among the United States, Mexico, and Canada.

42 CASE STUDY: Trade Agreements and the World Trade OrganizationGATTThe General Agreement on Tariffs and Trade (GATT) refers to a continuing series of negotiations among many of the world’s countries with a goal of promoting free trade.GATT has successfully reduced the average tariff among member countries from about 40 percent after WWII to about 5 percent today.

43 The effects of free trade can be determined by comparing the domestic price without trade to the world price.A low domestic price indicates that the country has a comparative advantage in producing the good and that the country will become an exporter.A high domestic price indicates that the rest of the world has a comparative advantage in producing the good and that the country will become an importer.

44 When a country allows trade and becomes an exporter of a good, producers of the good are better off, and consumers of the good are worse off.When a country allows trade and becomes an importer of a good, consumers of the good are better off, and producers are worse off.

45 A tariff—a tax on imports—moves a market closer to the equilibrium that would exist without trade, and therefore reduces the gains from trade.Import quotas will have effects similar to those of tariffs.

46 There are various arguments for restricting trade: protecting jobs, defending national security, helping infant industries, preventing unfair competition, and responding to foreign trade restrictions.Economists, however, believe that free trade is usually the better policy.

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